Will I Be Able To Keep My Tax Refunds If I File For Bankruptcy?

Tax refunds are always a challenging topic in bankruptcy because there are so many ways that different jurisdictions treat them.  To get a definitive answer regarding your situation, you need to talk to an experienced bankruptcy attorney in your area.  I will endeavor to explain to you the most common treatments of tax refunds in bankruptcy.

In Chapter 7, a tax refund is analyzed in a similar manner to other assets, with a few key distinctions.  Some elements of your income tax refund may be fully exempt.  This includes such items as the Child Tax Credit and the Earned Income Credit.  If you receive those as part of your tax refund, you are able to keep them.  To keep the remainder of your tax refund, you will need to have another exemption available to place on it, such as the wildcard exemption.  

The timing of your bankruptcy filing may be extremely important with regards to your tax refund.  Chapter 7 filings usually spike during tax refund season for two reasons.  First, many people wait until they receive their tax refund and use it to pay off their legal fees for bankruptcy and other necessary expenses that they have put off.  So long as these expenditures are reasonable and necessary, such as making repairs to the house or car or purchasing clothes for the kids, they are not subjected to too much scrutiny.  Second, bankruptcy trustees are unlikely to keep their case open until the next tax season so that they can seize next year’s tax refund.  As the year progresses after the tax refund is received, the risk grows that the trustee will pursue the tax refund as an asset of the bankruptcy estate.

In Chapter 13, it’s a whole different ball game.  Since, by definition, a Chapter 13 plan is expected to last for three to five years, tax refunds must be taken into account when calculating the repayment plan.  How this is done, however, varies greatly between jurisdictions and, in some situations, between individual cases within the same jurisdiction.  

Some jurisdictions require that the tax refund be estimated and then included as a monthly amount in your budget.  Since the refund is accounted for, when you actually receive the tax refund you are allowed to keep it.  You are expected, however, to use that refund through the year to maintain the budget that you submitted with the court.

Other jurisdictions require that you estimate your annual tax refund and schedule it as an additional plan payment each year.  

Still others have “fixed contributions” from the tax refund to the Chapter 13 plan.  You, as the debtor, are allowed to keep a fixed dollar amount from the tax refund, such as $1,200.  The remainder is expected to be paid to the trustee as an additional payment every year that you are in the Chapter 13 plan.  

Finally, there are still a few jurisdictions out there that do not require contribution of tax refunds as part of a Chapter 13 plan and you are allowed to keep the full amount.

The bottom line is that if you normally receive a substantial income tax refund and are considering filing for bankruptcy protection, you want to have the advice of an experienced bankruptcy attorney to ensure that you are following whatever the local practice is and maximize the amount of the refund you are allowed to keep.